Investors are abandoning private credit funds due to growing concerns about bad loans

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Investors are abandoning publicly traded private credit funds as they face losses on bad loans, and fears are growing that artificial intelligence will wreak havoc on the software companies they fund.

These vehicles, known as business development companies, are trading at 82 percent of their asset value, their biggest discount since late 2022, and a sign that investors believe the funds will face more pain, according to Financial Times calculations based on the Standard & Poor’s BDC index.

The decline in the value of these companies, which traded at more than 100 cents on the dollar last September, has cast a pall over the broader $2 trillion private credit industry, increasing pressure on unlisted private credit funds facing a crisis. Increase in recoveries.

These vehicles, known as semi-liquid funds, have been a growth engine for private equity giants, including Blackstone, Ares Management and Blue All, providing lucrative management fees and helping to quadruple assets at business development companies since the end of 2020.

The decline in BDCs began last September when the Federal Reserve began cutting interest rates, impacting the yields offered by loans, which generally move in tandem with broader borrowing costs. The high-profile collapses of two automakers — First Brands and Tricolor — that month raised concerns about companies’ credit quality and underwriting standards.

Selling in business development companies has accelerated again after a wave of write-downs in several large funds over the past two weeks, including automobiles. Managed by KKRBlackRock, New Mountain, Apollo Global, and Blackstone wrote down the value of the loans they held. Funds managed by BlackRock, KKR, Morgan Stanley and Apollo also cut dividends on their vehicles.

Many wealthy retail investors have been attracted to the industry because of the high profits on offer, with annual total returns exceeding 8 percent over the past decade, according to Standard & Poor’s Global.

Recent downgrades as well as asset sales in some funds have “reignited concerns about the credit cycle” around the world Private creditsaid Paul Johnson, an analyst at KBW.

“A lot has been piled into the space and it will probably stay that way…until they resolve these earnings cuts,” he said. Johnson added that he suspects deep discounts on publicly listed BDCs and recent scrutiny of the industry will impact new allocations to private BDCs.

Losses in recent days were spread across a number of corporate loans, including one to Medallia, a software company that was bought by a technology-focused company. Private equity Thoma Bravo for $6.4 billion in 2022. Exchange-listed funds managed by BlackRock and KKR lent money to Medallia.

blackrock fund, Known as BlackRock TCP CapitalIn late January, it wrote down the value of the loans it held, writing down its assets by 19 percent. Many of the distressed loans were made to companies that sold products on Amazon, including Razor Group and SellerX, as well as education technology company Edmentum.

“All of these positions were collateralized in a significantly lower base rate environment and faced challenges adjusting to persistently high interest rates,” BlackRock CEO Phil Tseng said on a call with analysts last week.

While a senior executive at a rival firm said the BlackRock fund “is not representative of the broader direct lending market,” its problems have reverberated across the industry, fraying investors’ nerves.

Johnson noted that although the fund had been “stressed” for years, “it’s hard to ignore the severe underperformance of a leading asset manager’s Business Development Bank these days.”

The BlackRock fund, which has delivered a total return of 43 per cent over the past year, is trading at a discount of more than 50 per cent to its net asset value. Apollo’s vehicle, known as MidCap Financial Investment, is priced at a 34 percent discount to the value of its fund, while KKR’s firm, FS KKR Capital, is trading at a 51 percent discount, according to Raymond James.

The technology fund managed by Blue Owl, which earlier this year permanently halted redemptions on one of its funds, also traded at a discount.

“We are playing a defensive role,” said Tim Musial, head of fixed income at CIBC Private Wealth, which has been reducing BDC Bank exposure. “You’re not getting paid enough to stick your neck out now.”

Additional reporting by Michelle Chan